Full text of Economic Synopses : Border Effects, 2003, No. 16

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Economic SYNOPSES
short essays and reports on the economic issues of the day
2003 ■ Number 16

Border Effects
Patricia S. Pollard
he law of one price states that identical goods sold
in different countries should sell for the same price
when prices are expressed in a common currency.
If, for example, pencils were cheaper in Canada than in the
United States, individuals could purchase them in Canada
and sell them in the United States at a profit. Such actions
would raise the price in Canada and lower the price in the
United States. In reality, factors such as transportation costs
and other barriers to trade (such as import restrictions)
limit the law of one price.
One way the Internet should reduce deviations from the
law of one price is by reducing the search costs required to
determine the lowest price. Consider, for example, a popular
on-line bookseller that operates in Canada and the United
States. One can access the Canadian or U.S. website to order
books for shipment to addresses in either country. A key
difference between the websites is that prices on the former
site are listed in Canadian dollars and prices on the latter
site are listed in U.S. dollars. Nonetheless, one would expect
that the prices for an identical book, when converted into
either currency, are identical.
To test this, I compiled a list of the 20 most popular
books sold on each site. Three books appeared on both lists
and four books on the Canadian list were not available on
the U.S. site, resulting in 33 books in the sample. I then
examined the prices of these books on each website. None
of the 33 books had identical prices when converted into a
common currency. In 6 cases the Canadian price was lower
and in 27 cases the U.S. price was lower.
The chart illustrates this result. If prices were identical
in the two countries, all points would lie on the 45-degree
line. Points below the line indicate that the price is lower
in Canada; points above the line indicate that the price is
lower in the United States.
Now, a lower sales price does not necessarily result in a
lower final price for the consumer. To receive the book,
the consumer must pay shipping costs. Of course, the cost
of domestic shipping is lower than the cost of international
shipping. For 3 of the 6 books in which the Canadian sales

T

price was lower and for 10 of the 27 books for which the
U.S. sales price was lower, the additional shipping costs
eliminated the price advantage of buying across the border.
For the 20 books where the price advantage of a crossborder purchase remained, the savings per book ranged
from $0.22 to $5.25. The average savings was $1.91 or 7
percent. Credit card fees on foreign currency transactions
(typically 1 to 3 percent) will reduce these savings to the
consumer. In addition, the time involved in converting
prices to a common currency and the extra shipping time
for cross-border purchases reduces even further the incentive for consumers to take advantage of the small savings
on these book purchases. Thus, while differences in book
prices across the border appear to violate the law of one
price, factoring in other costs makes the differences mostly
negligible. The law of one price appears to be a reasonable,
if imperfect, description of international prices for books
in this case. ■
Book Prices in Canada and the United States (US$)
Price in Canada
60

50

40

30

20

10

0
0

10

20

30
Price in U.S.

40

50

60

NOTE: One book whose price was above $100 was excluded from
the chart.

Views expressed do not necessarily reflect official positions of the Federal Reserve System.

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